Exchange Rate Systems

The Development of the Exchange Rate Systems

At the end of the World War II a fixed exchange rate system was started. In 1944 an agreement – the Bretton Woods agreement – was subscribed. It created a system of fixed exchange rates. The values of many major currencies were pegged to the value of the US dollar, which was fixed at 1/35 of an ounce of gold. The American Central Bank, the Federal Reserve, guaranteed that it could exchange an ounce of gold for $35.

From 1944 to 1971 the values of currencies were only rarely devalued or revalued, with the agreement of the International Monetary Fund.

In 1971 The system of Gold convertibility ended because the Federal reserve had no more gold, or at least not enough to satisfy the quantity of money, which was less worth than before because of the inflation.

In 1973 most industrialized countries switched to a system of floating rates. This meant that the rates fluctuated according to ‘market forces’: the supply of and the demand for different currencies in international markets. However, buying or selling by speculators could cause currencies to appreciate or depreciate by several percent in a very short time. Consequently, governments and central banks occasionally attempted to influence exchange rates by intervening in the markets: selling huge amounts of their currency to lower its price, or using their foreign currency reserves to buy it. So there was a system of managed floating exchange rates.

1992 represented a hard moment for English Economy, in fact the Bank of England lost over £5 billion in one day attempting to protect the value of the pound sterling. Speculators were trading so much currency that it was impossible for intervention by a central bank to change a floating exchange rate.

After this episode in 1992, governments and central banks intervened much less, so there was almost a freely floating system.

To avoid such fluctuations and to make commerce easier, in 2002 twelve states of the European Union introduced a single currency – called Euro – to replace their national currencies.